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Thursday, December 17, 2015

In this article, we will continue our study of the Introduction in James Rickards' book, "The Death of Money". Last time, we had an overview of what happened in the past. This time, we will see the similarities and differences between current events and the 1970s. However, Rickards' main focus in the remaining part of the Introduction is to provide an overview of the existing threats to the USD as world reserve currency.

Rickards claims that similarities could be seen in the decline of USD, appreciation of gold and the IMF's issuance of SDRs. The absence of inflation is the major distinction. The reasons why inflation is absent today is due to the fact that the US economy is already structurally damaged and that inflation though delayed through QEs will certainly come.

For Rickards, the impending collapse of the USD is not something new. He claims that such collapse already happened three times in the past: 1914, 1939, and 1971. Three major world events are also associated with these dates: WW1, WW2, and Nixon's abandonment of gold convertibility for the USD. As a result of such abandonment, the position of the USD as world reserve currency is now being threatened by currency war, hyperinflation, deflation, and market crash.

Currency war is a threat by way of using derivatives and penetrating exchanges in order to create public panic by selling huge number of shares.

As for inflation, James Rickards describes it as "the stealth destroyer of savings, capital, and economic growth" (p.12). The experience during the 1970s can teach us two lessons concerning inflation: first, that it takes several years for people to realize its impact, and second, that when perception about inflation takes place, it is extremely difficult to reset. Another noteworthy observation concerning inflation is the fast devaluation of the dollar and the appreciation of gold. The major difference is that this time China, Russia, and the IMF are already prepared in facing inflation with gold and SDR.

Deflation on the other hand, is the FR's worst nightmare due to following reasons: (1.) Real gains cannot be easily taxed. (2.) Deflation increases the real value of government debt. (3.) Deflation slows down GDP growth. (4.) It also increases the real value of private debt that may result to defaults and bankruptcies. (5.) Deflation feeds on itself and is nearly impossible for the Fed to reverse. For Rickards, the only solution to avoid deflation is for the US to declare a higher price for gold.

As a whole, market crash can be avoided if large banks are broken and most derivatives are banned. Out of the current crisis, a new monetary system could emerge which is based on gold, SDR, or a regional reserve currency.

Excerpts

"A similar constellation of symptoms to those of 1978 can be seen in the world economy today. In July 2011 the Federal Reserve dollar index hit an all-time low, over 4 percent below the October 1978 panic level. In August 2009 the IMF once again acted as a monetary first responder and rode to the rescue with a new issuance of SDRs, equivalent to $310 billion, increasing the SDRs in circulation by 850 percent. In early September gold prices reached an all-time high, near $1,900 per ounce, up more than 200 percent from the average price in 2006, just before the new depression began" (p. 9).

"The parallels between 1978 and recent events are eerie but imperfect. There was an element ravaging the world then that is not apparent today. It is the dog that didn’t bark: inflation. But the fact that we aren’t hearing the dog doesn’t mean it poses no danger" (ibid.).

"To understand the threats to the dollar, and potential policy responses by the Federal Reserve, it is necessary to see the dollar through the Fed’s eyes. From that perspective, inflation is not a threat; indeed, higher inflation is both the Fed’s answer to the debt crisis and a policy objective" (ibid.).

"This pro-inflation policy is an invitation to disaster, even as baffled Fed critics scratch their heads at the apparent absence of inflation in the face of unprecedented money printing by the Federal Reserve and other major central banks. Many ponder how it is that the Fed has increased the base money supply 400 percent since 2008 with practically no inflation. But two explanations are very much at hand—and they foretell the potential for collapse. The first is that the U.S. economy is structurally damaged, so the easy money cannot be put to good use. The second is that the inflation is coming. Both explanations are true—the economy is broken, and inflation is on its way" (ibid.).

"The coming collapse of the dollar and the international monetary system is entirely foreseeable. This is not a provocative conclusion. The international monetary system has collapsed three times in the past century—in 1914, 1939, and 1971. Each collapse was followed by a tumultuous period. The 1914 collapse was precipitated by the First World War and was followed later by alternating episodes of hyperinflation and depression from 1919 to 1922 before regaining stability in the mid1920s, albeit with a highly flawed gold standard that contributed to a new collapse in the 1930s. The Second World War caused the 1939 collapse, and stability was restored only with the Bretton Woods system, created in 1944. The 1971 collapse was precipitated by Nixon’s abandonment of gold convertibility for the dollar, although this dénouement had been years in the making, and it was followed by confusion, culminating in the near dollar collapse in 1978" (pp. 10-11).

"This book limns the most imminent threats to the dollar, likely to play out in the next few years, which are financial warfare, deflation, hyperinflation, and market collapse. Only nations and individuals who make provision today will survive the maelstrom to come" (p. 11).

Financial War

"Are we prepared to fight a financial war? The conduct of financial war is distinct from normal economic competition among nations because it involves intentional malicious acts rather than solely competitive ones. Financial war entails the use of derivatives and the penetration of exchanges to cause havoc, incite panic, and ultimately disable an enemy’s economy" (p. 11).

"The modern financial war arsenal includes covert hedge funds and cyber attacks that can compromise order-entry systems to mimic a flood of sell orders on stocks like Apple, Google, and IBM" (ibid.).

Inflation

"Critics from Richard Cantillon in the early eighteenth century to V. I. Lenin and John Maynard Keynes in the twentieth have been unanimous in their view that inflation is the stealth destroyer of savings, capital, and economic growth" (p. 12).

"Inflation often begins imperceptibly and gains a foothold before it is recognized. This lag in comprehension, important to central banks, is called money illusion, a phrase that refers to a perception that real wealth is being created, so that Keynesian 'animal spirits' are aroused. Only later is it discovered that bankers and astute investors captured the wealth, and everyday citizens are left with devalued savings, pensions, and life insurance" (ibid.).

"Two lessons from the 1960s and 1970s are highly pertinent today. The first is that inflation can gain substantial momentum before the general public notices it. It was not until 1974, nine years into an inflationary cycle, that inflation became a potent political issue and prominent public policy concern. This lag in momentum and perception is the essence of money illusion. Second, once inflation perceptions shift, they are extremely difficult to reset. In the Vietnam era, it took nine years for everyday Americans to focus on inflation, and an additional eleven years to reanchor expectations. Rolling a rock down a hill is much faster than pushing it back up to the top" (p. 12).

"More recently, since 2008 the Federal Reserve has printed over $3 trillion of new money, but without stoking much inflation in the United States. Still, the Fed has set an inflation target of at least 2.5 percent, possibly higher, and will not relent in printing money until that target is achieved. The Fed sees inflation as a way to dilute the real value of U.S. debt and avoid the specter of deflation. Therein lies a major risk. History and behavioral psychology both provide reason to believe that once the inflation goal is achieved and expectations are altered, a feedback loop will emerge in which higher inflation leads to higher inflation expectations, to even higher inflation, and so on. The Fed will not be able to arrest this feedback loop because its dynamic is a function not of monetary policy but of human nature" (p. 12).

"As the inflation feedback loop gains energy, a repetition of the late 1970s will be in prospect. Skyrocketing gold prices and a crashing dollar, two sides of the same coin, will happen quickly. The difference between the next episode of runaway inflation and the last is that Russia, China, and the IMF will stand ready with gold and SDRs, not dollars, to provide new reserve assets. When the dollar next falls from the high wire, there will be no net" (ibid.).

Deflation

"The United States would have experienced severe deflation from 2009 to 2013 but for massive money printing by the Federal Reserve. The U.S. economy’s prevailing deflationary drift has not disappeared. It has only been papered over" (p. 13).

"Deflation is the Federal Reserve’s worst nightmare for many reasons. Real gains from deflation cannot easily be taxed. If a school administrator earns $100,000 per year, prices are constant, and she receives a 5 percent raise, her real pretax standard of living has increased $5,000, but the government taxes the increase, leaving less for the individual. But if her earnings are held constant, and prices drop 5 percent, she has the same $5,000 increase in her standard of living, but the government cannot tax the gain because it comes in the form of lower prices rather than higher wages" (ibid.)

"Deflation increases the real value of government debt, making it harder to repay. If deflation is not reversed, there will be an outright default on the national debt, rather than the less traumatic outcome of default-by-inflation. Deflation slows nominal GDP growth, while nominal debt rises every year due to budget deficits. This tends to increase the debt-to-GDP ratio, placing the United States on the same path as Greece and making a sovereign debt crisis more likely" (ibid.).

Deflation also increases the real value of private debt, creating a wave of defaults and bankruptcies. These losses then fall on the banks, causing a banking crisis. Since the primary mandate of the Federal Reserve is to prop up the banking system, deflation must be avoided because it induces bad debts that threaten bank solvency" (ibid.).

"Finally, deflation feeds on itself and is nearly impossible for the Fed to reverse. The Federal Reserve is confident about its ability to control inflation, although the lessons of the 1970s show that extreme measures may be required. The Fed has no illusions about the difficulty of ending deflation. When cash becomes more valuable by the day, deflation’s defining feature, people and businesses hoard it and do not spend or invest. This hoarding crushes aggregate demand and causes GDP to plunge. This is why the Fed has printed over $3 trillion of new money since 2008—to bar deflation from starting in the first place. The most likely path of Federal Reserve policy in the years ahead is the continuation of massive money printing to fend off deflation. The operative assumption at the Fed is that any inflationary consequences can be dealt with in due course" (ibid).

"In such a circumstance, the only way to break deflation is for the United States to declare by executive order that gold’s price is, say, $7,000 per ounce, possibly higher. The Federal Reserve could make this price stick by conducting open-market operations on behalf of the Treasury using the gold in Fort Knox. The Fed would be a gold buyer at $6,900 per ounce and a seller at $7,100 per ounce in order to maintain a $7,000-per-ounce price. The purpose would not be to enrich gold holders but to reset general price levels. Such moves may seem unlikely, but they would be effective. Since nothing moves in isolation, this kind of dollar devaluation against gold would quickly be reflected in higher dollar prices for everything else. The world of $7,000 gold is also the world of $400-per-barrel oil and $100-per ounce silver. Deflation’s back can be broken when the dollar is devalued against gold, as occurred in 1933 when the United States revalued gold from $20.67 per ounce to $35.00 per ounce, a 41 percent dollar devaluation. If the United States faces severe deflation again, the antidote of dollar devaluation against gold will be the same, because there is no other solution when printing money fails' (p. 14).

Market Collapse

"The solutions to this systemic risk overhang are surprisingly straightforward. The immediate tasks would be to break up large banks and ban most derivatives. Large banks are not necessary to global finance" (p. 14).

"The case for banning most derivatives is even more straightforward. Derivatives serve practically no purpose except to enrich bankers through opaque pricing and to deceive investors through off-the balance-sheet accounting. Whatever the merits of these strategies, the prospects for dissolving large banks or banning derivatives are nil. This is because regulators use obsolete models or rely on the bankers’ own models, leaving them unable to perceive systemic risk. Congress will not act because the members, by and large, are in thrall to bank political contributions" (p. 15).

"Banking and derivatives risk will continue to grow, and the next collapse will be of unprecedented scope because the system scale is unprecedented. Since Federal Reserve resources were barely able to prevent complete collapse in 2008, it should be expected that an even larger collapse will overwhelm the Fed’s balance sheet. Since the Fed has printed over $3 trillion in a time of relative calm, it will not be politically feasible to respond in the future by printing another $3 trillion. The task of reliquefying the world will fall to the IMF, because the IMF will have the only clean balance sheet left among official institutions. The IMF will rise to the occasion with a towering issuance of SDRs, and this monetary operation will effectively end the dollar’s role as the leading reserve currency" (ibid).

Other Threats

"Russia and China are hardly alone in their desire to break free from the dollar standard. Iran and India may lead a move to an Asian reserve currency, and Gulf Cooperation Council members may chose to price oil exports in a new regional currency issued by a central bank based in the Persian Gulf" (p. 15)

"If the dollar collapses, the international monetary system will collapse as well; it cannot be otherwise. Everyday citizens, savers, and pensioners will be the main victims in the chaos that follows a collapse, although such a collapse does not mean the end of trade, finance, or banking. The major financial players, whether they be nations, banks, or multilateral institutions, will muddle through, while finance ministers, central bankers, and heads of state meet nonstop to patch together new rules of the game. If social unrest emerges before financial elites restore the system, nations are prepared with militarized police, armies, drones, surveillance, and executive orders to suppress discontent" (ibid.).

"The future international monetary system will not be based on dollars because China, Russia, oil producing countries, and other emerging nations will collectively insist on an end to U.S. monetary hegemony and the creation of a new monetary standard. Whether the new monetary standard will be based on gold, SDRs, or a network of regional reserve currencies remains to be seen" (pp. 15-16).

Guide Questions:

1. What are the similarities and the major difference between 1978 and recent events?

2. What changes took place among the three financial assets in 2011?

3. Why inflation is missing in recent financial events? What are the reasons for such absence?

4. Give the three dates where the financial system collapsed in the past. What three major events are associated with this financial collapse.

5. What are the four major threats to the dollar's supremacy?

6. Briefly explain your own understanding of currency war.

7. What is the unanimous opinion of economists concerning inflation?

8. What is "money illusion"? Why do you think the majority find it difficult to liberate his mind from such illusion?

9. What two lessons can we learn about inflation from the 1960s and 1970s?

10. What similarities and major difference Rickards anticipates that will happen between now and the 1970s once inflation occurs?

11. What is the FR worst nightmare? Why?

12. For Rickards, what is the only solution to avoid deflation?

13. How about the remedy to market collapse?

14. What are the potential alternatives to the existing dollar supremacy?

Source: Rickards, J. (2014). The Death of Money: The Coming Collapse of the International Monetary System. New York: Penguin Group.

Important financial events took place between 1977 to 1981 such as the nearly cessation of the USD as world reserve currency in 1978, 50% loss of USD's purchasing power, 50% US inflation, IMF's issuance of 12.1 B SDRs, and the 500% appreciation of gold from 1977 to 1980. The US Treasury responded immediately by issuing government bonds denominated in Swiss francs.

The threat to USD status as world reserve currency was the natural outcome of President Nixon's abandonment of its connection to gold in August 1971. Without the firm decision of President Ronald Reagan and Fed Chairman Paul Volcker, there was no way that the USD could be saved. Both Reagan and Volcker introduced monetary and economic reforms, which include 19% rate hike, and cutting taxes and regulations. As a result, the USD rallied 50% and gold price dropped 60% in March 1985, and inflation dropped from 13.5% in 1986 to 1.9% in 1980, and the age of King USD had begun in 1986.

Excerpts

"Few Americans in our time recall that the dollar nearly ceased to function as the world’s reserve currency in 1978. That year the Federal Reserve dollar index declined to a distressingly low level, and the U.S. Treasury was forced to issue government bonds denominated in Swiss francs. Foreign creditors no longer trusted the U.S. dollar as a store of value. The dollar was losing purchasing power, dropping by half from 1977 to 1981; U.S. inflation was over 50 percent during those five years. Starting in 1979, the International Monetary Fund (IMF) had little choice but to mobilize its resources to issue world money (special drawing rights, or SDRs). It flooded the market with 12.1 billion SDRs to provide liquidity as global confidence in the dollar declined. We would do well to recall those dark days. The price of gold rose 500 percent from 1977 to 1980" (p.8).

"While the dollar panic reached a crescendo in the late 1970s, lost confidence was felt as early as August 1971, immediately after President Nixon’s abandonment of the gold-backed dollar" (ibid.).

"The subsequent efforts of Fed chairman Paul Volcker and the newly elected Ronald Reagan would save the dollar. Volcker raised interest rates to 19 percent in 1981 to snuff out inflation and make the dollar an attractive choice for foreign capital. Beginning in 1981, Reagan cut taxes and regulation, which restored business confidence and made the United States a magnet for foreign investment. By March 1985, the dollar index had rallied 50 percent from its October 1978 low, and gold prices had dropped 60 percent from their 1980 high. The U.S. inflation rate fell from 13.5 percent in 1980 to 1.9 percent in 1986. . . . By the mid-1980s, the fire was out, and the age of King Dollar had begun" (p. 9).

Guide Questions

1. What important financial events took place between 1977 to 1981?

2. What was the immediate response of the US treasury to prevent such threat?

3. What caused the USD crisis between 1977 to 1981?

4. How was the USD saved?

5. What were the results of the decision of Reagan and Volcker?

Source: Rickards, J. (2014). The Death of Money: The Coming Collapse of the International Monetary System. New York: Penguin Group.

Saturday, November 21, 2015

The Death of Money is all about the death of the USD, the collapse of the existing monetary system, and the emergence of a new system. This will take place once confidence in USD is lost, and without an alternative currency to replace the USD, the financial system will crash. James Rickards describes the impending collapse of the current monetary system as unprecedented. He identified the existing and impending threats to the USD include currency war, deflation, hyperinflation, and market collapse.

The book also shows to investors the overview of risks in the current financial system and the best strategies to protect themselves financially. The book's message is timely in a time that investors are confused. The author describes the current state of existing monetary system as out of control. He mentions at least five factors that contributed to such chaotic condition and investors' confusion: altered state of global economy, the emergence of new players, "shifting allegiances, political ineptitude, and technological change" (p.16).

Guide Questions:

1. What is the book all about?

2. Why the international monetary system will collapse?

3. What are the existing and impending threats to the USD?

4. Why do you think James Rickards describes that the collapse of the existing monetary system is unprecedented?

5. How can the book help investors?

6. What made investors confused about the current financial system?

7. The author said that the existing global economy has been replaced. What do you think was the prior economic system before it has been replaced? And how would you describe the current system?

Source: Rickards, J. (2014). The Death of Money: The Coming Collapse of the International Monetary System. New York: Penguin Group.

Tuesday, August 4, 2015

"Attempts to carry out economic reforms from the monetary side can never amount to anything but an artificial stimulation of economic activity by an expansion of the circulation, and this, as must constantly be emphasized, must necessarily lead to crisis and depression. Recurring economic crises are nothing but the consequence of attempts, despite all the teachings of experience and all the warnings of the economists, to stimulate economic activity by means of additional credit."

As Ludwig von Mises concluded his 1934 Preface to the English edition of his book, he emphasized once again the danger of increasing credit expansion, which will eventually end into economic crisis. I wonder why after more than eight decades and with the accessibility of information in our time, the wisdom of the Austrian school of economics is still largely ignored by academic institutions and policy makers. I cannot avoid but to think that perhaps the political control of money is really addictive on the part of government officials and those who benefit from the system. Perhaps, it is really such a great temptation that is too difficult to resist. And so regardless of setting up parameters to avoid the abuse of this power, history teaches us that government's control over the monetary system has always been abused to the detriment of the people's welfare.

Monday, August 3, 2015

"The dislocation of the monetary and credit system that is nowadays going on everywhere is not due . . . to any inadequacy of the gold standard. The thing for which the monetary system of our time is chiefly blamed, the fall in prices during the last five years, is not the fault of the gold standard, but the inevitable and ineluctable consequence of the expansion of credit, which was bound to lead eventually to a collapse. And the thing which is chiefly advocated as a remedy is nothing but another expansion of credit, such as certainly might lead to a transitory boom, but would be bound to end in a correspondingly severer crisis."

"The difficulties of the monetary and credit system are only a part of the great economic difficulties under which the world is at present suffering. It is not only the monetary and credit system that is out of gear, but the whole economic system. For years past, the economic policy of all countries has been in conflict with the principles on which the nineteenth century built up the welfare of the nations. International division of labour is now regarded as an evil, and there is a demand for a return to the autarchy of remote antiquity. Every importation of foreign goods is heralded as a misfortune, to be averted at all costs. With prodigious ardour, mighty political parties proclaim the gospel that peace on earth is undesirable and that war alone means progress."

The role of the depreciation of local currency exerts big influence in an attempt of any nation to boost its export industry and to reduce importation of foreign products. Ludwig von Mises is clear at this point that this is one of the short-term effects of currency devaluation. However, such a stance is inimical to the interest of countries that rely more on their exports to strengthen their economy. If Mises' description therefore of the situation of global economy during his time is also appearing in our time particularly in relation to the way nations see the international division of labor and the importation of foregin goods, it is no wonder that we also have been hearing in our time the message that progress can only be obtained by means of war. In fact, not a few analysts are making a parallel between what's going on right now in global economy with the period prior to WW1 and WW2.

The two paragraphs above tell us about the interlocking connection among the condition of money, credit, and the economy. In particular, Ludwig von Mises talks about the dislocation of money and credit due to credit expansion. He even told us that "It is not only the monetary and credit system that is out of gear, but the whole economic system" due to the abandonment by the policy makers of his time of the principles that made capital formation and growth possible during the 19th century. Reading this, I see Mises as prescient as if he is also describing our time.

And then Mises proceeds to defend the gold standard that those who blame it for falling prices were actually mistaken. It was not the fault of the gold standard that prices fall. Instead, he identified credit expansion as the primary culprit.

What is tragic is that further credit expansion is perceived as the solution while ignoring the fact that it was the source of economic malaise in the first place. For majority of policy makers today, this faulty idea still remains. Yes, as we've seen in the formation of two recent bubbles (tech bubble and housing bubble in periods prior to 2000 and 2008 respectively), this credit expansion have resulted into "transitory boom," which will unavoidably lead to an economic collapse far worse than the two previous ones.

Sunday, August 2, 2015

"Gold is not an ideal basis for a monetary system. Like all human creations, the gold standard is not free from shortcomings; but in the existing circumstances there is no other way of emancipating the monetary system from the changing influences of party politics and government interference, either in the present or, so far as can be foreseen, in the future. And no monetary system that is not free from these influences will be able to form the basis of credit transactions. Those who blame the gold standard should not forget that it was the gold standard that enabled the civilization of the nineteenth century to spread beyond the old capitalistic countries of Western Europe, and made the wealth of these countries available for the development of the rest of the world." - (Source: Ludwig von Mises, The Theory of Money and Credit, 1953, p.19)

What does Ludwig von Mises want to communicate through the above passage? How would you interpret it? And how is it relevant to the existing monetary system?

The passage talks about the superiority of the gold standard over any form of political intervention in monetary affairs. Yes, Ludwig von Mises acknowledged that the gold standard is not perfect. However, he saw it as the only way to emancipate the monetary system from political control. It is implied in his words that the political control of monetary system is a threat to credit transaction for its very basis is unreliable. And then he concludes that those who dislike the gold standard have actually lost any historical sense. He cited the 19th century wealth formation and expansion as the outcome of following the gold standard.

How about our existing monetary system? Is it not under political control? Many people are not aware that the existing fiat currency is not actually an outcome of free-market monetary system; it is a product of the policy of interventionist government. Our money therefore is not a market money, but a political one. This explains the existing chaos both in the economic and monetary affairs of nations for these two are inseparable; money is the lifeblood of the economy. Once you tamper with it, you are overturning the foundation of society. John Maynard Keynes put it this way:

“There is no subtler nor surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Thursday, July 30, 2015

"Today we see considerations of the value of money driving all other considerations into the background in both domestic and international economic policy. We are not very far now from a state of affairs in which 'economic policy' is primarily understood to mean the question of influencing the purchasing power of money. Are we to maintain the present gold-content of the currency unit, or are we to go over to a lower gold-content? That is the question that forms the principal issue nowadays in the economic policies of all European and American countries. Perhaps we are already in the midst of a race to reduce the gold-content of the currency unit with the object of obtaining transitory advantages (which, moreover, are based on self-deception) in the commercial war which the nations of the civilized world have been waging for decades with increasing acrimony, and with disastrous effects upon the welfare of their subjects." - (Source: Ludwig von Mises, The Theory of Money and Credit, 1953, p.18)

In today's text, Ludwig von Mises mentioned a kind of "race" and "war" related to monetary system. I think such race and war did not stop in his time, but have been continuing to the 21st century. They might have changed in external forms, but the susbtance remains the same. I see the relevance of the text in relation to a popular idea in our time, the reality of the so-called "race to the bottom".

Today, the concept of race to the bottom is understood in different ways. In Financial Times, it is defined as:

"The situation in which companies and countries try to compete with each other by cutting wages and living standards for workers, and the production of goods is moved to the place where the wages are lowest and the workers have the fewest rights."

This is not the kind of race I see in reading Mises' text. The race that Financial Times describes pertains to a situation related to competition, the reduction of "wages and living standards of workers", and the transfer of goods and services to areas "where the wages are lowest and the workers have the fewer rights." To me, such definition paints a negative impression of those who are perceived to have authority in reducing the salary and the living standards of workers. The definition fails to account the source of the reduction of wage and living standard, which the Mises' text can provide.

Another definition of "race to the bottom" is given by Wikipedia:

"The race to the bottom is a socio-economic phenomenon in which governments deregulate the business environment or taxes in order to attract or retain economic activity in their jurisdictions, resulting in lower wages, worse working conditions and fewer environmental protections. An outcome of globalization and free trade, the phenomenon may occur when competition increases between geographic areas over a particular sector of trade and production."

In this definition, Wikipedia is more specific than the Financial Times in identifying the kind of situation where this race is taking place. Wikipedia is clear in describing this race as a "a socio-economic phenomenon" and adds four more ideas to competition, lower wages and "worse working conditions". These are "deregulation", "fewer environmental protections", "globalization", and "free trade". Again, this definition fails to explain the root cause of lower wages and worse working conditions.

The above definitions are consistent with the dominant intellectual framework in our time, which is anti-free market at its core. In the case of our text, the kind of race Mises was describing was related to the reduction of "the gold-content of the currency unit." We do not have this kind of race in our time for currency these days are no longer connected to gold. What nations are doing now is they are competing with each other in devaluing their own currencies. And since nothing backs up these currencies except the governments themselves, our race at present is far worse than Mises' time.

Mises saw that during his time the act of nations to race with each other in reducing the gold-content of currency was economically disastrous. Today, since all currencies are no longer connected to gold, would it not be logical to say that the continuation of the existing monetary system is more economically disastrous?

Nations pursued the above race to attain transitory advantages. They include boosting the export industry, restricting import of foreign goods, easing the financial burden of local companies with big debts, preventing the fall of wages, and maintaining the prices of goods and services. For Ludwig von Mises, this pursuit is based on self-deception for in reality by doing this, nations are engaged in "commercial war," which is economically disastrous to their citizens.

Wednesday, July 29, 2015

"At the very moment when the manipulation of purchasing power is declared to be a legitimate concern of currency policy, the question of the level at which this purchasing power is to be fixed will attain the highest political significance. Under the gold standard, the determination of the value of money is dependent upon the profitability of gold production. To some, this may appear a disadvantage; and it is certain that it introduces an incalculable factor into economic activity. Nevertheless, it does not lay the prices of commodities open to violent and sudden changes from the monetary side. The biggest variations in the value of money that we have experienced during the last century have not originated in the circumstances of gold production, but in the policies of governments and banks of issue. Dependence of the value of money on the production of gold does at least mean its independence of the politics of the hour. The dissociation of the currencies from a definitive and unchangeable gold parity has made the value of money a plaything of politics." - (Source: Ludwig von Mises, The Theory of Money and Credit, 1953, pp. 17-18)

Not many people today are aware that the existing monetary system called the "managed fiat currency standard" is actually not a result of the decision of the market, but of the political class. That's why it's difficult to understand intellectuals who blame the market for the present economic chaos. This only shows that mainstream education has been successful in its goal of mind control.

As we've seen already in previous post, government's use of inconvertible notes leads to currency devaluation. In reality, this political act is a manipulation of the purchasing power of the consumers. It is not the fault of the market that prices of goods and services are increasing unnaturally. Politics play a big role in it.

Prior to 1971, though the value of US dollar in relation to gold had already declined dramatically, at least, some measure of limitation on politics was still maintained. After President Nixon disconnected the US dollar from gold, the political control of money has been completed. The present turmoil both in the larger economy, the stocks and the financial markets are just inevitable consequences after more than four decades of ignoring sound money.

Ludwig von Mises was emphatic that what endangers the value of nations' currencies are "the policies of government and banks of issue." In order to discontinue this subtle erosion of the value of money, the way is to return to the gold standard. This will stop the "value of money a plaything of politics". Only under the gold standard that the manipulation of the purchasing power of consumers by politicians can be terminated. Understanding therefore this "old monetary system" is the way to arrest the monetary devaluation that is continually destroying the people's purchasing power. This will liberate money from political control.

"In Central Europe, the first country to follow Great Britain's example was the Republic of Czecho-Slovakia. In the years immediately after the War, Czecho-Slovakia, for reasons of prestige, had heedlessly followed a policy which aimed at raising the value of the krone, and she did not come to a halt until she was forced to recognize that increasing the value of her currency meant hindering the exportation of her products, facilitating the importation of foreign products, and seriously imperilling the solvency of all those enterprises that had procured a more or less considerable portion of their working capital by way of bank credit. During the first few weeks of the present year, however, the gold-parity of the krone was reduced in order to lighten the burden of the debtor enterprises, and in order to prevent a fall of wages and prices and so to encourage exportation and restrict importation. Today, in every country in the world, no question is so eagerly debated as that of whether the purchasing power of the monetary unit shall be maintained or reduced." - Source: The Theory of Money and Credit, pp. 16-17

The passage is about the short-term benefits of currency depreciation. All in all, Ludwig von Mises identified five immediate benefits so far:

During his time, Mises mentioned Czecho-Slovakia as the country which adopted this policy of currency depreciation after the example of Great Britain. Previously, Czecho-Slovakia practiced the stronger currency policy. But after witnessing the impact of a strong krone on both export and import, the government decided to change its direction.

Moreover, strong krone that time would also mean putting the domestic companies, which depend on bank credit for their working capital on a serious financial risk. And so krone was depreciated in order to reduce the financial burden of these local companies.

Reading this section, I realized that during Mises' time, currency depreciation was a hot issue in every country. Today, yes, it's becoming hotter in countries that are aware about what's going on in global economy. How about in the Philippines? Is this the kind of issue that is now being publicly debated? Why not? Are we not part of the global economy? Or do our policy makers think that our economy is too strong and protected from currency depreciation? In fact, not many Filipinos are aware that we are following the same path as the United States in terms of monetary depreciation.

Currency depreciation is a serious monetary and economic issue that affects our standard of living. Politicians cannot see the long-term detrimental results of such monetary policy for they only focus on immediate results. I wish and pray that the deafening silence about this very important subject will soon be stopped. And that the Lord will raise political leaders that truly understand this topic and will bring it into public attention.

Tuesday, July 28, 2015

How about the text below? How do you understand this passage? And why is its message relevant for our time?

"But the motive for recent experiments in depreciation has been by no means fiscal. The gold content of the monetary unit has been reduced in order to maintain the domestic wage-level and price level, and in order to secure advantages for home industry against its competitors in international trade. . . . In this case, however, Great Britain began by abandoning the old gold content of the pound. Instead of preserving its gold-value by employing the customary and never-failing remedy of raising the bankrate, the government and parliament of the United Kingdom, with bank-rate at 4.5 per cent, preferred to stop the redemption of notes at the old legal parity and so to cause a considerable fall in the value of sterling. The object was to prevent a further fall of prices in England and above all, apparently, to avoid a situation in which reductions of wages would be necessary."

"The example of Great Britain was followed by other countries, notably by the United States. President Roosevelt reduced the gold content of the dollar because he wished to prevent a fall in wages and to restore the price-level of the prosperous period between 1926 and 1929."

In the above text, Ludwig von Mises continued his explanation about monetary depreciation as the unavoidable outcome of government's utility of inconvertible notes. Here, he indicates that the government's intention in depreciating the currency is not primarily fiscal, that is, not related to the increase of tax collection and to the increase of spending ability. The motive says Mises is threefold: to influence the level of workers' salary, to maintain the prices of goods and services, and to protect local industry from its foreign competitors. The last is the essence of protectionism and a favorite tool of an interventionist government. This shows that a country that practice this does not really have a free market economy. This reminds me of Hitler's style, the other face of socialism.

Currency devaluation during Mises' time was done through the reduction of gold content in monetary unit. In our time, it's different since as far as I know, no existing currency is backed up by gold since 1971 when President Nixon disconnected the USD from this precious metal. However, the act of monetary depreciation remains. The external form of this depreciation is different, but the essence of the act stays the same.

I think the text is relevant to our time for we are facing the same issue in today's monetary system. As England depreciated its sterling/pound in the past, the US has been depreciating the dollar for so long. I think we are touching the root of the existing crisis in global economy. Since money is the lifeblood of the economy, it is difficult to see the solution to the present problem economic as long as both governments and central banks of the world are committed to currency devaluation.

"When governments do not feel strong enough to procure by taxation or borrowing the resources to meet what they regard as irreducible expenditure, or, alternatively, so to restrict their expenditure that they are able to make do with the revenue that they have, recourse on their part to the issue of inconvertible notes and a consequent fall in the value of money is something that has occurred more than once in European and American history" (The Theory of Money and Credit, p. 15).

I'm having difficulty "decoding" the meaning of this long sentence by Ludwig von Mises. What is he saying here?

The way I see it, Ludwig von Mises combined four ideas in one sentence:

1. About government's hesitation between taxing the people and borrowing money or restricting its expenditures with the available funds provided by current taxes,

2. That if a government is not satisfied between these two options, it will choose to fund its programs using "the issue of inconvertible notes,"

3. That resorting to such way of providing fund for its expenditures will result to currency devaluation, and

4. That this kind of government action is not new, but has a root in European and American history.

The most difficult part in the above sentence is to exactly find out the meaning of "inconvertible notes". I googled it, and what appears are links to the definition of "convertible notes". I googled it again and add Mises' name, and there we can see links to his book The Theory of Money and Credit, but still I cannot find the exact meaning of the term "inconvertible notes". And so I decided to just deduce its meaning from the definition of convertible notes.

Reading the Financial Times, I see that "Convertible notes are often used by angel investors who wish to fund businesses. . ." These "notes are structured as loans at the time the investment is made." These notes are described as "convertible" because they can be "automatically converted to equity" later on.

Now, let us return to the meaning of "the issue of inconvertible notes" that will be used by the government to fund its expenditures. Who will issue this inconvertible banks? The central bank? Why these notes are described as "inconvertible"? I do not know the exact answer. All I can do is guess. Perhaps unlike the convetible notes, these inconvertible notes cannot be converted into equity. But I assumed that they can be converted into cash. For if not, then how can a government provide a fund for its expenditures?

To me, I understand inconvertible notes as a form of loan that will be used by the government for its programs, which will be financed by the people through taxes in the future. The quote also talks about three ways the government fund its expenditures:

1. Through direct taxation,

2. Through direct borrowing, and

3. Through the issue of inconvertibles notes, which to me is a form of indirect taxation and indirect debt.

Directly taxing the people and borrowing money are better ways to source out fund in a sense that it is obvious and the taxpayers can see their impact on their personal and family expenses. And because of this, each individual and family can adjust financially. This I think what makes inconvertible notes dangerous. I wonder how many citizens understand its nature. But Mises is clear that once the government used this credit instrument, the outcome is monetary depreciation. So inconvertible notes are also taxes, but done in an indirect way that make them invisible. I suspect that the use of these notes has a lot to say about monetary corruption and the ongoing crisis in global economy. Utilizing this tool, politicians can expropriate the people without the latter knowing how it is being done. Government has found people's pockets as an unlimited source of fund.

Saturday, June 27, 2015

Contrary to mainstream story, the global economy has not recovered from the 2008 crisis. Instead, it was expanded even more. Once central banks stop these QEs, the real situation of the economy will be exposed. And so the best alternative at this point is to address the problem following the free market way to recovery. In any case, economic pain is unavoidable.

The free market solution will lead to the reduction in asset prices and debts. The primary obstacles to this solution are the interventionist policies of the government in the form of bailouts and increased taxation of the wealthy. Such policies discouraged saving and are rooted in the myth that increased consumption is good for a struggling economy. However, for Austrian economists, to stimulate consumption in the midst of recession is not only foolish, but will aggravate the situation even more. Better listen to these economists if we really want to find the way to economic recovery.

In the last chapter of Thomas E. Woods Jr.s' book, "Meltdown: A Free Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse," the author offers concrete steps to recovery from a free-market perspective. We can reduce these steps into four:

1. Allow firms to declare bankruptcy. This solution should first be applied to Fannie and Freddie, which Woods calls as "zombie companies." These state-sponsored enterprises have already brought so much distortion to mortgage market that should be stopped.

However, this bankruptcy solution is avoided due to two baseless fears. One is related to the perceived negative impact on the economy once firms disappeared. Woods corrects this misconception. He argues that in case of bankruptcy, firms will not disappear. Instead, there will be a change in ownership of assets from incapable to capable hands. Woods cited Enron to prove that "its bankruptcy in 2001 had no effect on the economy at all, and even energy markets barely noticed it" (p. 147).

The second fear is about the lost of credit. This is the justification in bailing out banks. Woods thinks that it is unnecessary for in our time, it is now easier to raise capital outside the banking system. He identified selling bonds, issuing stock, and borrowing overseas as examples.

2. "Stop the bailouts and cut government spending." Excessive consumption and too much debt caused the 2008 crisis. It cannot be cured by continuing the same practice. Bailouts and increase in government spending are just the other faces of persisting in excessive spending and borrowing. This too must stop.

3. Demand transparency from the Fed. Though Woods did not directly recommend to end the Fed, I think he is happy to see its abolition. He does not like this institution for its impact on US economy is the exact opposite of its official purpose. He sees it as a source of economic instability, "unnecessary," "disruptive," and intrusive to the market economy. And the Americans can only realize the destructive impact of the Fed on US economy if its records will undergo public scrutiny. The Fed must identify the recipients of its bailout program and the collateral backing up such loans.

4. Keep the government away from the monopoly and manipulation of money. Again, I think this serves as the primary reason for the abolition of the Fed for it is through this institution that the US government is actually monopolozing and manipulating the monetary system. Various proposals have been made as a replacement. The goal in mind is to keep the government away from money for Woods sees no role for government to "play in the monetary system that can confer any kind of social benefit" (p. 154). Citing Ludwig von Mises, Woods narrates:

". . . the history of money is the history of government efforts to destroy money. If ever there was a monopoly with which government could not be trusted, this is it. The temptation to debase the money and impoverish the people in order to benefit favored constituencies, hoping most people won't know the source of their declining standard of living, is too great" (ibid.).

Tuesday, May 26, 2015

We will skip chapters 4 and 5 of Thomas E. Woods Jr.'s "Meltdown: A Free Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse" for these chapters describe about the business cycle and the Great Depression in the 1930s. The business cycle chapter in particular is a discussion of F. A. Hayek's concept, which I think is better considered using the book of Hayek's intellectual mentor himself, Ludwig von Mises. I am referring to the "Human Action" specifically Chapter 20 Sections 8 and 9. I summarized this topic in three articles:

Our primary concern in the present article is about money. In particular we want to talk about the separation between money and State. We have been told that in the past, the separation between church and state was a great accomplishment that prevented numerous abuses. Likewise, living in an interventionist age, the blogger agrees that a new kind of separation is needed in our time for citizens of nations to live in freedom, peace and prosperity. This is the separation of money and state.

For most people, this idea is next to impossible. Governments and central banks will not allow this to happen not unless citizens become economically informed. This ideal can only be achieved if an intellectual revolution would occur as a result of people's search for an answer once the existing interventionist crisis reached its ultimate end.

I think Chapter 6 of Thomas Woods' book will help us understand how to achieve the identified separation. Woods explains this by exposing two popular myths and by introducing fundamental economic and monetary concepts.

Two Popular Myths

The first myth is economic. It has something to do with the role of the Federal Reserve. It is difficult to break the spell of this myth for almost everybody is asking for it. This is how Woods describes this myth: "We need the Fed to push down rates so there can be more borrowing and lending. Then we'll be prosperous" (p. 126).

The problem with this superstition is that the Fed itself has no resources of its own to lend, except the USD coming from the printing press. This kind of credit does not come from people's saving. It is just being created out of paper and ink.

The second myth is monetary. The focus of this fallacy is hostility towards commodity money such as silver and gold. It has at least five different versions. Woods enumerates them as follows:

1. "Gold and silver aren't flexible enough. We need money that is more flexible." The key in understanding this fallacy is to know how the term "flexibility" is used by those who are hostile to commodity money. Once you understand this term, you will also see that being "inflexible" is in fact a virtue of gold and silver.

2. "Precious metals are too bulky." This can be easily dismissed for debit cards can be "used with a precious metal money" (p. 131).

3. "A gold standard is too costly; paper money is les expensive to produce." The mistake in using this line of reasoning is the failure to see the real cost of paper money, which is the enrichment of the political and bureaucratic class at the expense of the taxpayers.

4. "There isn't enough gold or silver to facilitate all the transactions of a modern economy." Woods disagrees with this for he believes that sufficient quantity of gold or silver exists to facilitate market transactions. Furthermore, he does not believe that increasing the money supply will benefit the economy apart from the growth in the quantity of products and services. In fact, he cited the experience of the Americans during the 19th century that a relative "constant money supply" was matched with the increase in goods and services. This resulted to lower prices and growth in the purchasing power of people's money, and thereby also increased the American's standard of living.

5. "The supply of gold cannot keep up with the growth in business activity." This is just an extension of the previous myth. For Woods, there is no need to increase the money supply just to offset the fall in prices. Doing so, is the primary cause of the business cycle.

Fundamental Economic and Monetary Concepts

In beginning chapter 6, Woods complains about the exclusion of critical monetary issues from mainstream discussion. He identified five of them:

1. The existing monetary system has depreciated 95% of the value of the USD.

2. The existing monetary system is an indirect way of expropriating the people.

3. The existing monetary system with the power of the Federal Reserve to control interest rates is the cause of the business cycle.

4. That there is a need for a new monetary system and policy

5. That the kind of monetary policy we need is the one that will discourage "reckless leveraging and risk-taking."

The central concept that Woods argued throughout the book is that the current banking system and its monetary policy is the source of economic instability and miscalculation. After exposing the above two myths, we will now identify the fundamental economic and monetary concepts that Woods wants to introduce.

The first concept is about the source of money. Money is not a government creation. It originated from the market. And since at present, we are all used to paper money, Woods argues that for it to have value, it must have a connection to commodity money.

The second concept is about the process how governments arrived to its present monopoly of money. Woods explains this process in three stages:

1. It all starts with the market's use of commodity money.

2. The circulation of paper notes started as a substitude of commodity money.

3. The government confiscates the commodity money.

For Woods, such act of confiscation is a "violation of private property rights" and "it always involves the threat of violence" (p. 113).

Roman Catholic scholasticism championed the third concept. Two examples of popular thinkers from this school include Nicholas Oresme (1323-82) and Juan de Mariana (1536-1624). They condemned the act of monetary debasement as a violation of the 8th commandment.

The fourth concept is about the qualities possessed by gold and silver that qualified them as money: durability, divisibility, and relatively valuable. Other Austrian economists add scarcity and transportability.

The fifth concept is about the connection of commodity to liberty. Woods echoed the argument of Joseph Schumpeter that "a commodity standard was the only monetary system compatible with freedom." The other face of this argument is that under the existing fiat monetary system, tyranny is winning the day.

The sixth concept is about the Federal Reserve. Woods does not believe that the Fed was established for the good of the American public. Instead, it was a "special interest" institution disguising as working for public good.

The seventh concept is about the confusion regarding the meaning of inflation. I don't want to elaborate on this further for I already wrote about this topic. You can find it here:

The final concept is about deflation. This is what most economists are afraid of today. Contrary to popular belief, Austrian economists like Thomas E. Woods Jr. does not believe that falling prices result to economic difficulties. Instead, he affirms that falling prices is either "the natural outcome of a progressing market economy" (p. 135) or an indication of depressed economic condition after a series of inflationary measures has been stopped.

The blogger agrees with Thomas E. Woods Jr. that unless people will understand the identified fallacies and the basic concepts discussed in chapter 6 of his book, American economy as well as the global economy will continually sink deeper into economic abyss. The journey to freedom, peace and prosperity will only start once the tie between money and state is disconnected.

Guide Questions:

1. How did Thomas Woods explain the concept of separation between money and state?

2. What are the two popular myths? Briefly explain each.

3. Enumerate the five versions of monetary myth.

4. What are the five critical monetary issues excluded from mainstream discussion?

Tuesday, April 28, 2015

A friend and at the same time a student of mine asked me a question this morning. "How do you define success? What's your understanding of success?" she asked.

Since I am thinking about my children's future and for some time I have been contemplating about designing a specific curriculum for them, I want to answer my friend's question in terms of educational perspective.

I see success as obtaining true education. By this, I mean not the popular way of seeing it, finishing a college degree or even attaining a master or a doctoral degree. Though I acknowledge that such academic accomplishment is necessary to enter into the system, I have personally witnessed not a few masters and doctors that in my view of education will not pass and also fewer still who haven't achieved advanced degrees but displayed the real essence of education.

The most important thing in education is the ability to see and understand what's really going on in society and also having the ability to respond to such reality. The problem with current education is that the graduates I happened to talk to feel themselves at a loss and unequipped in facing the challenges of today. In fact, despite their intelligence they fail to see what's really going on out there. "Education" has a lot to do for this blindness.

For humanist educators, education is all about knowing yourself as a man and knowing the world around you. They immediately dismiss the idea that education has something to do with God, man and the world. Removing one of these will distort the entire process.

In line with this concept of education, I want to design a curriculum for my children that will touch three basic realities of life. This project will be long-term. I don't expect it to be finished in a year or two. This will be a continuing process as I journey with my children. These three basic realities have something to do with the spiritual, intellectual and financial aspects of man.

The spiritual aspect of education will focus on Christian liberty. The Bible and theology play a significant role in achieving this goal. I see this concept of freedom that includes the spiritual, the economic and the financial freedom of an individual. Spiritual freedom talks about freedom from sin received by grace through faith in King Jesus. That is why any talk of freedom without grace is doomed to fail from the very start. True and genuine freedom starts by grace.

When it comes to economic freedom, I want to adopt the study of Friedrich Naumann Foundation. There are four variables in FNF's understanding of economic freedom: security of property rights; the size of government; the regulation of credit, labour, and business, and; the freedom to trade internationally. However, I do not want to follow FNF in dropping the fifth variable, but I want to follow the Fraser Institute instead in which I think is the most important variable of all - access to sound money. This concept of economic freedom is closely connected, or it is more proper to say, rooted in the intellectual aspect of education.

When we approach the concept of financial freedom, we borrow this idea from financial literacy literature. I understand financial freedom as the ability to financially support yourself without relying on anyone. Others see financial freedom as reaching the level where an individual's passive income is bigger than his expenses. Both concepts express the same goal in different words. I just want to keep it that way.

Except for grace, two other important concepts are inherent in my idea of Christian liberty, peace and prosperity.

Turning from the spiritual aspect into the intellectual aspect of education, basic knowledge of economics equips the person to think, critique, and offer alternative way of viewing the world. Talk about capitalism and socialism is very important at this stage. Interventionism is the most important context at this point.

Since a lot of advocates of "capitalism" are out there, it is better to distinguish our understanding of capitalism from the popular one. We reject crony capitalism or corporatism. We understand capitalism as synonymous to free market. To grasp this distinction, one must have a basic understanding of how a free society really works. Studying the literature from the Austrian school of economics will help us achieve this intellectual goal.

So far, the first two aspects provide the ideological level of education. In the third and last aspect of education, we are approaching the practical side. This time, we will be dealing with personal finance and investment strategies. In personal finance, the two most important skills are money management and understanding the correlation among the income statement, the balance sheet and cash flow. In investment strategies, four additional skills are needed: stock picking, how to research firms, reading financial corporate statements and stock valuation to determine the financial soundness of a company.